October 30, 2006
Michael Pickens Pleads Guilty to Securities Fraud Charges
Michael Pickens, the son of famed corporate raider T. Boone Pickens, entered a guilty plea to three counts of securities fraud. The government brought the charges in July 2005 (see earlier post here) related to a scheme to send out hundreds of thousands of faxes containing purported inside information about small companies, and the faxes were made to appear to be misdirected to the wrong number. Gullible recipients who thought they'd stumbled on the next big investment opportunity bought the shares that allowed Pickens and his cohorts dump their stock in the companies at inflated prices. Pickens was also involved in a bizarre case in Connecticut in June 2006 when he was charged with burglarizing a fly fishing store (see earlier post here). In the securities case, he is looking at a sentence around five years. An AP story (here) discusses the guilty plea. (ph)
The Coming Push Against Corporate Enforcement
A New York Times article (here) discusses growing efforts to cut back on investigations and enforcement actions against corporations and related professionals on both the civil and criminal front. While vague about any actual proposals, the article discusses various groups that are looking to adopt changes in the Sarbanes-Oxley Act, particularly the internal controls provision in Section 404, and issues related to the Thompson Memorandum concerning waiver of the attorney-client privilege and payment of attorney's fees for individual officers and directors. In a sense, none of this is particularly new. The push-back against Section 404 has been going on for the past two years as companies experience the costs of the internal controls required to meet the regulatory requirements and encounter problems with auditors who will fly-speck corporation books to limit their own potential liability. The Thompson Memorandum has been attacked on a number of fronts, and an earlier post (here) quotes Senator Arlen Specter that he plans to introduce legislation to prohibit consideration of waiver of the attorney-client privilege and attorney's fee payments when prosecutors decide whether to charge a corporation with a crime.
The Times article sheds light on new efforts to constrain the ability of state Attorney Generals -- read Eliot Spitzer -- to bring broad charges against large businesses under state law. Much like the cut-backs in private securities litigation (PSLRA and SLUSA), this would likely involve federalizing certain areas that would deprive the states of their jurisdiction over certain industries or transactions. The problem with such an approach is that the states and their AGs could find ways around federal laws, and it's not clear whether such legislation could pass without expanding the federal law enforcement bureaucracy, which seems to run counter to the proposal's goal. Another issue mentioned in the article is a recommendation to prohibit private parties from filing Section 10(b)/Rule 10b-5 securities fraud actions, leaving only the SEC to enforce the broad antifraud provision. This would be truly radical because private actions far outnumber the enforcement cases filed by the SEC, and some significant recoveries in private securities fraud actions have provided relief to investors (and the lawyers, too). Given the Commission's limited resources, many cases would never end up in court, and perhaps never even be investigated. As I recall, the Commission has fairly consistently supported the private right of action under the securities laws, so it would likely oppose such a move. Moreover, as discussed in earlier posts (here and here), Congress has harped on the SEC's failure to police hedge funds and pursue insider trading cases with sufficient vigor, so adding to the agency's workload by giving it exclusive power over Rule 10b-5 cases without a commensurate expansion of its budget might not be politically palatable.
No specific recommendations have appeared, and legislative or administrative proposals have not been unveiled, so there is no way to know what will be offered in the name of reform. One problem for any set of proposals is that they must avoid being labeled the "Corporate Crime Relief Act of 2007" or, worse, the "CEO Get-Out-Of-Jail-Free Act" if they appear to be too favorable to companies and executives. With soaring CEO pay in the news amid options-timing cases that are starting to pop to the surface, this might not be the best time to recommend changes that make it significantly more difficult to investigate corporate misconduct. (ph)
Another Former CEO to be Sentenced
Former Computer Associates, Inc. CEO Sanjay Kumar will be sentenced on securities fraud and obstruction of justice charges related to accounting fraud at the computer software company now known as CA Inc. Kumar entered a guilty plea after being indicted along with the company's former general counsel for participating in an ongoing fraud that involved booking revenues in one quarter even though the contracts had not yet been concluded. In what was called the "CA Way" the company had "35-day months" at the end of quarters when sales made five days into the next month would be counted in the previous month, thereby increasing the revenue for that period. Kumar was also involved in back-dating other contracts and sending the GC to Hawai'i to bribe a potential witness in the case. An interesting aspect of the obstruction charges was that the government included in the description of the offense efforts to mislead and lie to the outside law firm hired by the company to conduct the internal investigation on the ground that Kumar knew the misstatements would be given to prosecutors. A Wall Street Journal article (here) notes speculation that Kumar will receive a term between eight and twelve years. One variable is whether the district court will impose a higher sentence because of the obstruction of justice, the type of charge that tends to have a very negative effect on judges. (ph)
October 29, 2006
Will the SEC Prime the Enforcement Pump?
The Government Accountability Office will take a look at the SEC's enforcement program in response to a letter from Senator Charles Grassley regarding how the Commission is pursuing insider trading and other types of securities fraud cases. A Bloomberg story (here) discusses the Senator's request. The letter came as a result of charges leveled by former Enforcement Division attorney Gary Aguirre, who claimed that an insider trading investigation of hedge fund firm Pequot Capital Management and Morgan Stanley CEO John Mack was snuffed out due to outside pressure that prevented him from taking testimony from Mack. After a Senate Judiciary Committee hearing on regulation of hedge funds that included Aguirre as a witness, the Commission subsequently went through with the deposition of Mack in August 2005. Shortly thereafter, the staff determined that it would not recommend that civil charges be filed (see earlier post here).
The GAO audit will no doubt increase the pressure on the SEC to process its cases more quickly and perhaps cut down a bit on the bureaucracy that builds up in any agency over time. A Wall Street Journal story (here) notes that the number of enforcement actions has dropped since its peak in 2003, and likely will be below 600 for the 2006 fiscal year that ended on September 30. Whenever the numbers fall, there are questions raised about the agency's effectiveness, and those issues become more troublesome after the SEC had its budget increased in order to police the markets more closely.
Simply counting the number of cases filed may not be the best way to measure an agency's effectiveness, and I suspect one result of the GAO (and congressional) scrutiny will be to push cases through to show a quick response to any potential weaknesses in the Enforcement Division's management. The Commission has investigations of over 100 companies for options back-dating, and while a few of those will produce criminal charges, a number will likely result in administrative actions at a minimum because of the false financial statements, and perhaps could even lead to civil enforcement actions for securities fraud. That probably means there will be a cascade of cases over the next year, especially to pump up the numbers for FY2007 to have the groundwork ready for when the GAO issues its report. There is no better way to respond to criticism than to point to current numbers and note an increase in the number of cases, just like corporations do when reporting their quarterly financials. Unfortunately, when the heat is on to generate "stats" for Congress, the quality of the cases may not mean as much as getting a quick settlement. Like all types of law enforcement, there is an ebb and flow to the cases, and look for the flow to be heavier over the next twelve months . . . almost like channel-stuffing. (ph)
Deferred Prosecution Agreements and Government Power
Professor Brandon Garrett of the University of Virginia School of Law has posted an article on SSRN (here) on deferred prosecution agreements that will appear in the Virginia Law Review in 2007. Professor Garrett analyzes the deferred prosecution agreements the Department of Justice has entered into with a number of companies over the past few years, and looks at how the agreements are targeting changes in internal corporate governance. He questions whether prosecutors may be abusing their power by inserting unrelated terms into such agreements, which do not have the benefit of judicial review. The abstract of the article states:
In what I call a structural reform prosecution, prosecutors secure the cooperation of an organization in adopting sweeping internal reforms rather than seek its conviction for criminal acts of its agents. Dozens of leading corporations in the past few years entered into demanding settlements with federal prosecutors, including AIG, American Online, Bristol-Myers Squibb Co., Computer Associates, HealthSouth, KPMG, MCI, Merrill Lynch & Co, Monsanto, and Time Warner. Nevertheless, no scholars have considered the problem of prosecutors seeking structural reform remedies. I conducted an empirical study of the terms in the agreements the DOJ has negotiated to date, which reveals that federal prosecutors consistently imposed deep governance reforms, but also unrelated terms indicating potential abuses of their power. Unlike in civil rights cases that long accomplished court-supervised institutional reform, prosecutors designed settlements to avoid judicial review of their terms or implementation. We should carefully examine this bold new prosecutorial mission because it fundamentally transforms federal criminal law, affects entire industries, and yet appears to lack any due process safeguards. I frame and evaluate five models that prosecutors can adopt to pursue structural reforms. Prosecutors have chosen the model that departs most radically from prior federal organizational criminal law. I conclude that in time, however, judicial limits will constrain prosecutorial discretion and result in a more effective regime for deterring organizational crime.